Agency Metrics

Transcript: Agency Metrics

Speaker 1:

Welcome to the Agency Management Institute community, where you’ll learn how to grow and scale your business, attract and retain the best talent, make more money, and keep more of what you make. The Build a Better Agency Podcast presented by White Label IQ is packed with insights on how small to midsize agencies survive and thrive in today’s market. Bringing his 25 plus years of experience as both an agency owner and agency consultant, please welcome your host, Drew McLellan.

Speaker 2:

Hey everybody. Drew McLellan here from Agency Management Institute. Welcome to another episode of Build a Better Agency. Super excited to have you here, and I’m excited about this topic that we’re going to talk about today because I think it’s so important to your agency’s success. So I will tell you about that in a quick second. I want to remind you… I haven’t talked about this very much yet, but I want to remind you that the Build a Better Agency Summit is coming up in May of ’23, which seems far away but as we all know in agency life that’ll be here in a blink. Tickets are on sale now and we have an amazing lineup of speakers. We’re going to talk about leadership. We’re going to talk about presenting to sell. We’re going to talk about agency evolution. We are going to talk about fear and imposter syndrome. We are going to talk about all kinds of different topics that are related to running your agency well.

So again, bigger picture, stepping back, working on the business for a couple of days, we would love to have you join us. If you go over to the Agency Management Institute website, if you look in the upper left corner it says BaBA Summit. You can click there, you can read more about this summit. We’re in Chicago again in ’23. You can grab your ticket now before we sell out and we would love to have you join us. So I’ll tell you more as the months come ahead about our speakers, but it is really an amazing lineup and I’m super excited about it. So I would love to have you join us. All right, let me tell a little bit about our guests. So Marcel Petitpas was an agency owner and decided that he wanted to move on to something different. He had an idea for how to help agencies do the agency math that they needed to better, created some software, does a lot of consulting, but is very much focused on agency finances and metrics.

And so he and I often have great conversations around this topic. He loves to dig deep into how agencies can be more profitable every single day. And so I’m excited to have him on the show and to share his wisdom with all of you. And I know that a lot of you don’t like to talk about the numbers, and I know a lot of you don’t like math. But I know a lot of you like to take care of your family and take good care of your team. And I’m telling you what we’re going to talk about for the next hour is exactly that. So it is outcome based, it is profit based, it is taking care of the people you love based. So yes, you have to do a little math but I promise its easy math and it’s super smart math that will help you make better decisions in your agency every single day. So with that, let’s get to the conversation because I know he has a lot to teach us. Hey, welcome to the podcast. Thanks for coming back.

Speaker 3:

Man, it is great to be here, Drew. I just want you to know that your show is one I’ve been listening to for a very long time, and you are one of the thought leaders that I learned a lot from when I first got into this industry. So it’s a kind of surreal moment for me to be on the show today. I really appreciate you having me.

Speaker 2:

Well, I think you and I have had a lot of conversations over the years. I think our philosophies about agency management and operations, and mostly importantly what to measure and what you measure matters. I think we’re in alignment, so I’m looking forward to the conversation. For the listeners, give them a little sense of your background, how you came to be in the role that you’re in today and where the passion for this stuff comes from.

Speaker 3:

Great question. So like most folks I ran an agency, that was my first business. We did real estate virtual reality services back before you could do it with your cell phone. And very early on I ran up against the challenges of trying to figure out the basic questions in the business. Are we making money on clients and projects? Can I hire other people to do this work? And is there enough margin here? And all the reasons that that’s just way harder than I felt like it needed to be at the time. I walked away from that business because I figured out at that time, very different real estate market than what we’re experiencing today. But houses would sit for several years. Real estate agents were not really willing to invest a lot of money in this kind of very fancy digital assets. And so I figured out pretty early I was not going to be able to scale the business beyond me doing the work, which I didn’t really enjoy doing.

And so I walked away, got into software because I guess I’m a sucker for punishment. I don’t know. And a few years later got a phone call from a friend of mine that runs a software development agency out of Boise. And he just said, “Man, I spend hours every week building spreadsheets trying to answer these questions. There has to be a better way to do this. I want to solve this problem.” And I knew right away this had been a problem for myself. And so that was the impetus for Parakeeto to start. That was about four years ago now. And since then I’ve just been laser focused on trying to solve this problem better than anyone in the world. And really empowering agencies that don’t have the scale or the resources to buy enterprise software and put a data science team together, to be able to get the insights into the most important and very simple numbers that will drive the business in the right direction.

Speaker 2:

And so now in your current role of owning this company, you come alongside agencies and with the software help them be able to sort of measure the metrics that you believe are critical for agency success, correct?

Speaker 3:

That’s right, yeah. And we’ve really pivoted, we started as a software company trying to solve this only with software. And I think we realized at some juncture that we were part of the problem. The problem is not that there’s a lack of software, I think you and I both know this [inaudible 00:06:12]. But there’s no market that’s more ripe for a private equity roll up then, time tracking and project management. And it’s not that we don’t have good tools to capture the data. So much of the problem was actually the strategy. What data are we looking at? How is it structured? Are we measuring things in the right way and are our tools set up to give us that information? And then it’s the data cleanliness, because people are never going to be perfect at data input. They’re never going to follow the naming convention perfectly or track time at the right level.

So those were really the problems that we realized were undermining people’s ability to do this. So we’ve transitioned to much more of a consulting firm that’s leveraged by technology. So a lot of the time we spend with clients is much more strategic. And the simple thing is actually setting the tools up and tracking the time, once we’ve gone through the painstaking process of figuring out exactly how should that be done for this business.

Speaker 2:

So I’m curious, what do you think the most important metric for an agency to measure is? Before we hit the record button, we were discussing whether or not we would disagree on anything. So we maybe five minutes in and I already have a disagreement, so we’ll see where we land.

Speaker 3:

I’m excited. So this is a metric that I call delivery margin. And I’ve had to start calling it delivery margin because accountants call it gross margin or contribution margin, but half the time they’re not even measuring it in the right way. So I’m going to describe what I mean when I say delivery margin. It is the cost to earn a dollar of AGI essentially or their percentage margin on your AGI. So you want to get to agency gross income, which if you’re listening to this show hopefully you know what that is. It’s the revenue that actually belongs to your agency that you need to earn with your team’s time and effort. And then the cost of earning that agency gross income which is what we call delivery costs. That’s mostly payroll but usually a little bit of shared infrastructure as well, your Figma license, your stock footage library, four to 6% of your AGI and the audits that we’ve done typically falls into what we call shared delivery costs.

But then it’s mostly your delivery payroll. That to me is the thing that almost nobody can see, almost nobody’s paying attention to but is the foundation for agency profitability. You can go and try to cut your overhead all you want, half the time that’s not the problem. It’s about the ratio of cost in your delivery team to how much income they can generate, that to me is the foundation. And if that’s healthy, everything else tends to take care of itself as long as you’re not trying to buy everybody’s $700 office chairs and things like that.

Speaker 2:

Yeah. So as you said, it’s basically you’re looking at AGI and then looking at my labor costs, plus I heard you say four to 6% of your overhead costs. So in our world if agencies were living by the 55, 25, 20 rule, it would be looking at, let’s call it 60 to 63% of your operating costs, right?

Speaker 3:

Yeah, and typically what we’re advising clients is like you want to be above 50% delivery margin on the profit and loss statement. And if you can achieve that target closer to 60, of course if you can, but if you can achieve that presumably you’re going to spend anywhere from 20 to 30% of your agency gross income on overhead. And then that leaves you with a profit. But if you’re spending 20 to 30% of your agency gross income on overhead, which is probably what’s required to not basically lose all your team because you don’t have the right infrastructure, you don’t have the right systems to keep clients coming in, then if that deliver margin is any lower than 50% there’s really just not any meat on the bone. So that’s where your bottom line really comes from. Fiscal management at the overhead level can only go so far, if the fundamental foundation isn’t there then that’s the big problem.

Speaker 2:

Yeah. We collect full financials from the majority of our clients and certainly any of our clients who are in the peer groups. And so every year about this time, we’re looking at the aggregate sort of financial metrics of about 150 or 200 agencies. And it’s fascinating to me the average agency in the US makes less than 5% profit. They’re barely getting by. And AMI agencies, I think for 2021 they were at 17.65% profit. Not because they belong to AMI but because… I wish that were true that make selling a whole lot easier, but because we force them to measure it. And what I find is, and I don’t know about you, we teach a workshop called Money Matters every year and I’ll have agency owners that have been in the business for 20 years. And the basic terms of AGI and those ratios are still foreign to them. And so they literally are running their agency blind. So I’m curious what you find when you sit down with an agency client, how well versed are they in what we call agency math?

Speaker 3:

Very poorly most of the time. There’s exceptions, there are people that have done a lot of education, they’ve consumed some great resources. There are some great resources out there, although you have to go searching for them and they’re not easy to find always. But your content has been among the best content on this. You’re one of the few people that talks about this openly and introduces these concepts out into the world. But most do not have a solid understanding of this stuff. Very few, nine out of 10 clients when we look at their financial statements, they can’t easily discern their delivery margin because all their payroll is in one big account with everybody. All their software is in one big account with everybody. Their delivery costs are not isolated any way. Or they have picked up a handful of metrics here and there and they’re focused on those, but they don’t understand how they actually impact the business in the broader context.

So obsessions with utilization for example are… And to me, utilization is the most misunderstood metric in the agency world. And it’s the most dangerous as well. If it’s not used correctly, I think it could have negative impact on the business, substantially negative impact. And similarly, things like revenue per full-time employee, if you don’t understand the context with that metric, it’s kind of a vanity metric because it doesn’t tell you anything about margin. Like is 200,000 per FT good, well, if you’re in San Francisco probably not. If your team’s in… I don’t know, Delaware, maybe it’s better, I don’t know. But there’s a lot of misunderstanding. And I find that at the early stages of a business kind of getting up into that 20, 30 ish headcount, there’s just very little visibility going on. So that’s typically the problem we’re solving there is, let’s get you the visibility so that you can get past the stage of growth and empower your managers to make decisions.

But then we also work with larger clients that are in that 70, 100, 150 range. And often they have a lot of numbers, but they are being throttled by the level of precision they’re trying to achieve. They’re taking a metric like utilization and they’re piling all of this precision into it that’s adding no value to the strategic decision making that’s being done, but it creates all this operational drag. And so they come to us saying, we have an entire team of people that spend dozens of hours every week pulling time sheets and collecting all this data and all of these data points just to get us to the simple answer. And for them a lot of times it’s like really solidifying their understanding of how all these things connect together. So they know where things need to be precise and where they can add some levels of abstraction, and how all of these things kind of work together to lead them in the right direction.

Speaker 2:

Yeah, financial metrics for an agency is an ecosystem and you have to understand the whole ecosystem. So I want to go back to your delivery cost conversation. So when that ratio is on a whack, typically what’s the problem underneath that bad metric?

Speaker 3:

Well, there’s basically three ways to improve your delivery margin. If we think about the equation, it’s the ratio of AGI to cost. So the first thing you can do is decrease your cost. Of course, if it was that easy everybody would be doing it. But find people who are less expensive to do the same stuff that the expensive people are doing today.

Speaker 2:

At the same level of quality and speed and all the things that your seasoned people are good at doing.

Speaker 3:

Right, so that’s your first option. And for most people listening, that’s not the first door you want to open. So with that aside then the next question is, okay, well, how do we get the team that we’re currently working with to make more money with the available capacity that they have? And there’s basically two levers for that. The first is your average billable rate and the second is your utilization. So just to do some simple math, let’s imagine we have a team and they have 10,000 hours of capacity. And in all three of these examples, we’ll assume that the cost of that team is exactly the same. So if they’re doing a 50% utilization, that’s 5,000 hours per year that they are earning revenue for the business. And if they earn $100 per hour, then that team can earn $500,000 in AGI.

So depending on what that cost is that’s maybe good, maybe bad, I’m not sure. If we increase their average billable rate now at 5,000 hours per year to 125, now all of a sudden that same team is earning $625,000. So if you think about that relative to 500, that’s a massive improvement. That could be the difference between losing money and being very profitable. And if we combine that now with a 60% utilization, so we’re going from 5,000 to 6,000 hours of utilized time at that 125 rate, now they’re making $750,000 in AGI. That’s a 50% increase relative to the previous example. The team hasn’t changed, the payroll hasn’t changed, your overhead probably hasn’t changed-

Speaker 2:

No new clients, no new work, same work, yap, right.

Speaker 3:

Exactly. And so this is why I’m constantly saying, I think most agencies are suffering from indigestion and not starvation. They just happen to feel the same. And we see this all the time. People try to sell themselves out of this problem, it just makes it worse. So utilization and average billable rate are basically the other two levers. You want to look at them together always because you can trade one off onto the other. But that’s essentially the basic math between how do you take a team, assuming you can’t cut their costs and increase their productivity, you optimize for those two metrics.

Speaker 2:

Yeah. So you had said earlier that utilization is often sort of a misunderstood metric. Talk a little bit about that.

Speaker 3:

Yeah, so the first thing is not considering utilization in the context of average billable rates. So I think one of the biggest mistakes that I see agency owners make is the only exception to this maybe is if you run a pure time and material shop, and you can get away with growing through budgets and just your clients just still pays you for all that time. Now that’s an edge case-

Speaker 2:

But it’s very rare.

Speaker 3:

I don’t run into a lot of firms that are able to operate that way. So that case aside, assuming that you can’t just egregiously bill your client for all the time or your bright pricing things on flat rates, then holding your team accountable to a utilization target is just a really good way to motivate them to always make sure that they’re inflating time in the time sheets. But it’s disconnected from this idea of it’s actually not their responsibility to keep their utilization high, it’s yours and your project management teams. They don’t have any more work to do, but they’re going to walk into a team meeting next week and get their hand slapped because they weren’t at 65%.

Well, what’s Drew going to do if he doesn’t have enough hours or if doesn’t have enough work to do? Well, he’s just going to make the logo bigger and smaller until he hits his utilization target. So it muddies up your time tracking data which is the most vital set of information for you to measure, like what’s going on in the business. You don’t want to muddy that water. And if you think about how average billable rate is calculated, you take AGI that was earned across any section of the business and you divide it by the number of hours required to earn that. Well, if those hours are going up, the average billable rate’s going down. The net impact on your right AGI relative to your cost is not improving. So you’re actually not helping your profitability by increasing your utilization unless that comes with actually increasing it through giving your team more work to do or higher value work to do, so that’s one thing.

And then the second thing is the way that this metric is calculated, utilization is really simple on the surface capacity and billable hours. But when you start double clicking… And this is especially prominent in big organizations that we do audits for, we run stakeholder interviews. We ask 10 people on the team, what exactly is somebody’s capacity? We’ll get 10 different answers. Well, does it include time off? Does it not include time off? What about holidays? What about vacation time? And then what exactly is a billable hour? I don’t even like using the language billable hour because it has this connotation that if it’s billed to the client or not, it makes a difference. And in my mind it doesn’t. So we call it a delivery hour, but you ask 10 people what’s a billable hour? What qualifies, what doesn’t qualify?

And coming back to my earlier point, in organizations where the team is held accountable to utilization targets, well, you start to see weird stuff like working on the company website is now a billable hour because somebody complained in the meeting, well, that’s not fair. I’m getting slapped on the hand for poor utilization [inaudible 00:19:09]-

Speaker 2:

New business too, right?

Speaker 3:

100%. And so you end up with just this completely convoluted, way more complicated than it needs to be calculation. In my mind, utilization at the highest level is total capacity. So if you work 40 hours a week, your capacity is 40 hours and delivery hours. Any time spent working for clients, moving client deliverables forward, whether it increases or decreases the rate that they pay you or not. That is the fundamental calculation for utilization. It’s horizontally consistent so you can see better patterns. It’s simpler, so there’s less operational drag behind it. And it doesn’t consider productivity, it doesn’t consider any of those things. But those two aspects, how it should be used and how it should be calculated, I almost never see people get that right.

Speaker 2:

Well, and as you were saying even in the same organization, how the CEO defines it, how the CFO defines it, how an account manager defines it, nobody really has that consistent measure. And you’re right, it becomes… I think you call it a vanity metric. It becomes I have to hit this metric. But again, if you don’t understand the whole ecosystem what you may actually be doing is costing yourself money.

Speaker 3:

And I literally just got off a call before getting on this where somebody told me we bonus our team based on a utilization target, and I almost passed out on the call. That’s such a bad idea. To me, delivery margin is probably the… If you’re going to bonus your team on performance, probably the best metric to use because it’s tensioned properly. There’s all this tension built into it that considers utilization but also considers average billable rates. So maybe use that. But to bonus your team based on utilization, to me it’s going to drive really bad incentives and it’s not going to lead to good outcomes in my experience.

Speaker 2:

Yap. All right, so there’s two things that you said that I want to dig into. I want to talk about agencies billable rates, because it seems like especially in the last two years everybody should be paying attention to that with all the higher costs of employees and all of that. And two, you said something about time sheets being a critical metric and I harp on that all the time. So I want someone else to harp on it too. But first I’ll take a quick break and then we’ll go back to those two things. Hey there, just a quick interruption. I want to make sure that you are aware that you are cordially invited, not just invited but cordially invited to join our private Facebook group. All you have to do is go to Facebook and search for Build a Better Agency and you’ll find the Facebook group.

You have to answer three quick questions. You have to put in the agency URL, you have to talk about what you want to learn from the group and you have to promise to behave yourself. And that’s it. And then we’ll let you in and you can jump into the conversation with over 1000 other agency owners and leaders. And there’s a robust conversation happening every day. People are sharing resources and best practices and discussing everything from work, from home policies, to maternity and paternity policies, to biz dev strategies. So come join us and jump into the conversation. All right, speaking of conversations, let’s head back. All right, we are back and we are talking about agency metrics. All right, so let’s talk about what are you seeing around billable rates? Are you seeing most people are doing a flat across the board blended rate? Are you seeing some agencies are still doing the Bob is $200 and Bert’s 100 dollars? So what are you seeing and are you seeing agencies start to increase their billable rate?

Speaker 3:

It’s a good question. So I have this conversation probably four to six times a week. It’s one of the first things I ask clients about when we get on a sales conversation, because I want to understand how their business works and talk about our solution in that context. I see a lot of things going on and sometimes even within the same agency a lot of different things going on, where one department uses a blended rate when another one uses a rate card. But what’s common is that [inaudible 00:23:17], oh yeah, it’s crazy the amount of complexity I see-

Speaker 2:

Okay, I’m not seeing a lot of that, thank God.

Speaker 3:

That’s completely unnecessary complexity. But you know how it gets there, right? It’s you’re always busy, you add a new department, a new service line. It’s just kind of built off the side of somebody’s desk and this is how it works. And I understand the context behind why things get so messy, but I see all kinds of different things. Almost never is that hourly rate actually based on some idea of a margin target though that somebody wants to hit. The answer I get most often is, well, we kind of know what other agencies are charging or it’s based on the market. But underneath that, there isn’t this like, oh well, we know we want to target a 60 or 70% kind of margin on our average cost per hour, so that’s why we set the rate card where it is, or the blended rate where it is, or the day rate or whatever that looks like.

And then you have the value priced agencies that of course are pricing based on value. But what they’re often not doing is actually checking to see if there’s margin in the value price. It’s great price on value, get that price as high as you can but you should probably check to make sure that you’ve got enough margin for that price to actually make sense. Otherwise, you’re not actually realizing the benefit of a value based price. So we see a lot of different things going on. I will say that generally we are se